The European Union's announcement that it will finance the modernization of Ukraine's gas pipeline system has sparked fresh tensions with Russia, whose state-run gas behemoth now looks like the odd man out as EU companies get set to propel the project forward.

Prime Minister Vladimir Putin was among the first Russian officials to respond to the news of the EU-Ukraine agreement. His reaction left little room for ambiguity.

"If Russia's interests are going to be ignored, we will be compelled to begin reviewing the principles of our relations with our partners," Putin said.

If Russia's sentiments needed clarification, the following day Putin and President Dmitry Medvedev announced that a planned meeting next week between Putin and Ukrainian Prime Minister Yuliya Tymoshenko had been postponed indefinitely. The meeting was to discuss cash-strapped Kyiv's request for a $5 billion loan from Russia.

Putin's warning suggests that relations between Russia and the EU and Ukraine, at least concerning gas supplies, may once again be entering rough waters. Tensions calmed only recently after a dispute this winter over Ukrainian debts to Moscow and gas and transit prices led to temporary cuts in Russian gas supplies to the EU.

Moscow Miffed

Europe gets about 40 percent of its imported gas from Russia, and much of that comes via Ukraine.

Kyiv's pipeline system is in desperate need of modernization, and for years Gazprom has assumed it would do that work and become at least a part-owner. But Kyiv has been clear about not wanting to hand over any part of its pipeline system to any Russian company.

On March 23, the EU and Ukraine announced that the EU would provide 2.5 billion euros to upgrade Ukraine's 13,500 kilometers of natural-gas pipelines. While the deal did not explicitly say it, analysts appear convinced that EU companies are likely to carry out that work. The deal also raised speculation that EU firms may become operators of Kyiv's pipeline system.

Adding to the fresh tensions is the EU's Eastern Partnership program, officially unveiled last week, which aims to improve relations with ex-Soviet republics (Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine) and similarly does not involve Russia directly.

Russian criticism of the EU-Ukraine deal has focused on Moscow's involvement in the project, given that the pipelines carry Russian gas.

Politics is clearly part of Russia's calculation, but economics is also in the equation. Gazprom this year will pay Ukraine some $2.3 billion euros in transit fees ($1.70 per 1,000 cubic meters per 100 kilometers). That pricing structure was part of a deal Russia and Ukraine reached in January to help end their recent gas dispute. Now it's at risk.

Russian Internet newspaper gazeta.ru reported on March 24 that if Ukraine's pipeline system comes under the ownership of EU companies, the transit fee will rise to the average European fee -- $3 per 1,000 cubic meters per 100 kilometers. According to gazeta.ru, "then [Gazprom] would need to pay some $3.9 billion per year" in transit fees.

The same report cited Gazprom estimates that the modernization of Ukraine's pipeline network would cost some $16 billion -- far more than what Ukraine is due to receive from the EU and European financial institutions.

When she signed the deal with the EU in Brussels, Prime Minister Tymoshenko indicated that Ukraine would retain ownership of its pipeline system.

"Our joint declaration states clearly that in accordance with Ukrainian law, Ukraine's gas transit system is and will remain state property," Tymoshenko said.

'Transfer Of Control'?

Some in the EU, and of course in Russia, believe that is not the case -- and that the EU will want some control over the Ukrainian system to ensure Russian gas reaches its destination in the EU.

Gazeta.ru suggested that the EU-Ukraine agreement "implies a transfer of control over the export part of the Ukrainian pipeline system to a new operator, most likely one of the big European companies."

There is also speculation that Russia's negative reaction to the EU-Ukraine deal is also intended to hinder improving ties between the EU and Ukraine.

At the same time, Russia is signaling interest in improving ties with the EU enough to realize two alternative gas pipeline projects that avoid Ukrainian territory -- Nord Stream under the Baltic Sea and South Stream under the Black Sea.

Nord Stream is due to start operations in 2011 and has EU support, particularly from Germany. When completed, Nord Stream will be capable of exporting about half the amount of Russian gas that now transits Ukraine.

The EU, while seemingly securing a victory in the Ukrainian pipeline battle, is now set to wade deeper into the treacherous waters of Ukrainian politics.

Tymoshenko and President Viktor Yushchenko were both at the signing ceremony in Brussels, but each has worked to marginalize the other in recent months.

Trying to retain some distance from that domestic power struggle is likely to prove challenging to the EU and any EU-based firms that take on the task of upgrading, and possibly managing, Ukraine's export pipeline system.